Final Misc. Itemized Deduction Regulations

The IRS has issued, effective today, final regulations for trusts and estates to follow on the proper treatment of expenses subject to the 2% floor for miscellaneous itemized deductions.

Background

Individuals and fiduciaries must reduce certain expenses, and not deduct the full amount, under IRC §67(a). These expenses include tax preparations fees, professional dues, home office expenses, and investment costs. IRC §67(e) says that expenses incurred by a trust are not limited if they “would not have been incurred if the property were not held in such trust or estate”. There has been must discussion about what expenses “would not have been incurred”.

The issue was litigated and reached the US Supreme Court who said (in 2008) that investment advisory fees incurred by trusts ARE subject to the 2%-floor limitation. Around that time, the IRS released temporary regulations regarding the deduction of certain expenses by trusts and estates. Those regulations are final and effective as of last Friday (May 9, 2014).

Regulations

The final regulations confirm that trusts and estates must subject expenses to the 2%-floor limitation any miscellaneous itemized deduction which “commonly or customarily would be incurred by a hypothetical individual holding the same property” [see Reg. §1.67-4(a)].

The regulation’s next section elaborates on the meaning of “commonly” and “customarily”. It discusses costs considered “ownership costs” (which are generally subject to limitation since an individual would incur the same costs); “tax preparation fees” (which EXCLUDE from limitation the cost of estate tax returns, all fiduciary income tax returns, and a decedent’s final Form 1040); “investment advisory fees” (which are generally subject to limitation, except for advice specifically identifiably as not likely to be incurred by an individual); and “appraisal fees” (which exclude from limitation the costs associated with appraisal’s for an estate’s or trust’s income tax return, or a GST tax return).

Other costs which are fiduciary in nature are not subject to the limitation; these include probate court fees and costs; fiduciary bond premiums, and other costs listed in the regulation. Not mentioned, but not subject to limitation, are trustees fees.

Bundled Fees

Finally, the regulation addresses the problem of bundled fees. If a trust or estate pays a single fee for services which are subject to limitation and services which are not subject to limitation, then the single fee must be separated and the appropriate part made subject to the limitation. The regulation permits any reasonable method of allocation to divide the single fee.

Application

The final regulation apply to tax years beginning on or after May 9, 2014. Previously issued (temporary) regulations have been removed. IRS Notices issued in 2008, 2010 and 2011 have been superseded by these final regulations.


See: TD 9664

Domestic vs. Foreign: Asset Protection Trusts

Sam Phillips at Donlevy-Rosen & Rosen, P.A. discusses the differences between Domestic Asset Protection Trusts (DAPTs) and Foreign Asset Protection Trusts (FAPTs).

A battle is raging between US-based attorneys over the use of Domestic Asset Protection Trusts (DAPTs) or their offshore counterparts (Foreign Asset Protection Trusts or FAPTs). Fifteen states (and counting) have enacted some form of asset protection trust legislation, but the efficacy of these DAPTs has been called into question since inception.

Gerry W. Beyer (of the Wills, Trusts & Estates Blog) reports that this was a focus of the 48th Annual Heckerling Institute on Estate Planning (held last month in Miami, FL).

Link: “Domestic Asset Protection Trusts Can Fail” says Estate Planning Expert

How to distribute excess tax payments — 2014

Trusts have the option (under IRC §643(g)) to treat any portion of a Federal payment of estimated tax made by a trust for any taxable year as a payment made by a beneficiary of the trust. The election to allocate must be made on or before the 65th day after the end of the tax year by filing Form 1041-T.

March 6

(The 65th day of 2014 is March 6. See related post here.)

The amount is treated as paid by the beneficiary on January 15 of the following tax year (for the purposes of calculating underpayment of estimated taxes); by making an election now, the tax will be treated as paid on January 15, 2014, and can be taken by the beneficiary as a credit against 2013 taxes.

This election may also be made by an estate, but only in its last taxable year.

This election may be useful for trusts which unexpectedly have little or no tax liability last year, or after distributions were made causing the tax liability to shift from the trust to the beneficiary.


New York allows a similar election with regards to NYS estimated tax payments made. The election and allocation must be made on Form IT-205-T. This form must be filed within 65 days of a trust’s year end (just like the Federal election).


Citation: IRC §643(g)

65-Day Rule — 2014

March 6

Fiduciaries of estates and complex trusts have the option to treat certain distributions as having occurred last year. An election can be made with respect to distributions made within 65 days after the end of a tax year. The 65th day of 2014 is Thursday, March 6.

Fiduciaries are allowed a deduction for amounts actually paid. During this 65-day period, a fiduciary can compute its fiduciary accounting income and distributable net income and compare these amounts to distributions already made during the year. If necessary, additional distributions can be made to balance the allocation of income between the fiduciary and beneficiary.

The election can be made on all or part of the additional distributions made. Therefore, a fiduciary can over distribute what might be necessary to pass out 2013 income to a beneficiary, but elect a smaller amount when the income tax return is prepared. Any amount distributed but not treated as 2013 distributions will naturally be 2014 distributions.

These distributions are then treated as having been made on the last day of 2013.

Remember that fiduciaries pay the highest tax rate (i.e. 39.6%) on all taxable income over $11,950 in 2013, and only have a personal exemption of either $100 (for complex trusts) or $600 (for estates). It may be advisable to make distributions to beneficiaries in a lower tax bracket for overall tax savings.

Example: A complex trust earned interest and ordinary dividends during 2013 of $20,000, and paid investment advisory fees of $2,000. If no distribution is made from the trust, the trust will pay federal income tax of $5,486. If the trustee makes a distribution to an income beneficiary in the 25% tax bracket, then she would have additional income tax of $4,500. The net tax savings is $986.

New in 2013: Net Investment Income Tax

In addition, fiduciaries must pay the Net Investment Income (NII) tax (at a rate of 3.8%) on the lesser of investment income or AGI over $11,950 (in 2013). Married individuals must pay the NII tax only if their AGI exceeds $250,000.

While taxes are not always the driving force behind trust administration decisions, they should always be considered.

Reporting: The Form 1041 does not require any kind of formal declaration of the amount of distributions paid in 2014 and treated as paid in 2013. (However, be sure to keep good records so that the amount is not reported again as a 2014 distribution.) There is a check box on the bottom of page 2 of the Form 1041 which must be checked when a §663(b) election has been made.

Timing: A §663(b) election must be made on a timely filed return (including extensions). The election becomes irrevocable once the due date of the return has passed [Reg. §1.663(b)-2.1]


Simple trusts are not required to consider actual distributions when determining the trust’s Income Distribution Deduction, as all accounting income is required to be distributed. If some amount of accounting income has not been distributed during a calendar year, then it should be distributed as soon as administratively possible, without regard to a hard 65-day limit.

Citation: IRC §663(b)